Industry Analysis: The Fundamentals
OUTLINE
• The objectives of industry analysis
• From environmental analysis to industry analysis
• Porter’s Five Forces Framework
• Applying industry analysis
• Industry & market boundaries
• Identifying Key Success Factors
The Objectives of Industry Analysis
• To understand how industry structure drives competition,
which determines the level of industry profitability.
• To assess industry attractiveness
• To use evidence on changes in industry structure to
forecast future profitability
• To formulate strategies to change industry structure to
improve industry profitability
• To identify Key Success Factors
From Environmental Analysis
to Industry Analysis
The national/
international
economy
Technology
Government
& Politics
The natural
environment
THE INDUSTRY
ENVIRONMENT
• Suppliers
• Competitors
• Customers
Demographic
structure
Social structure
•The Industry Environment lies at the core of the Macro Environment.
•The Macro Environment impacts the firm through its effect on the Industry
Environment.
Profitability of US Industries (selected industries only)
Median return on equity (%), 1999-2005
Household & Personal Products
Pharmaceuticals
Tobacco
Food Consumer Products
Securities
Diversified financials
Beverages
Mining & crude oil
Petroleum Refining
Medical Products & Equipment
Commercial Banks
Scientific & Photographic Equipt.
Apparel
Computer Software
Publishing, Printing
Health Care
Electronics, Electrical Equipment
Specialty Retailers
Computers, Office Equipment
22.7
22.3
21.6
19.6
18.9
18.3
18.8
17.8
17.3
17.2
15.5
15.0
14.4
13.9
13.5
13.1
13.0
13.0
11.7
Gas & Electric Utilities
10.4
Food and Drug Stores
10.0
Motor Vehicles & Parts
9.8
Hotels, Casinos, Resorts
9.7
Railroads
9.0
Insurance: Life and Health
8.6
Packaging & Containers
8.6
Insurance: Property & Casualty 8.3
Building Materials, Glass
8.3
Metals
8.0
Food Production
7.2
Forest and Paper Products
6.6
Semiconductors &
Electronic Components
5.9
Telecommunications
4.6
Communications Equipment
1.2
Entertainment
0.2
Airlines
(22.0)
The Profitability of Global Industries: Return on Invested Capital, 1963-2003
Utilities
6.2
Telecom s ervices
6.5
Trans poration
6.9
Energy
7.7
Materials
8.4
OVERALL AVERAGE
9
Retailing
9
Cons um er durables and apparel
9.5
Food retailing
9.6
Capital goods
9.9
Autom obiles and com ponents
9.9
Technology hardware and equipm ent
10.3
Hotels , res taurants , leis ure
10.3
Food, beverages , tobacco
11
11.3
Healthcare equipm ernt and s ervices
Sem iconductors
11.9
Com m ercial s ervices
12.8
Media
14.7
15
Com puter s oftware and s ervices
Hous ehold and pers onal products
15.2
Pharm aceuticals
18.4
0
5
10
Average ROIC 1963-2003 (%)
15
20
The Determinants of Industry
Profitability
3 key influences:
• The value of the product to customers
• The intensity of competition
• Relative bargaining power at different levels
within the value chain.
The Spectrum of Industry Structures
Perfect
Competition
Oligopoly
Duopoly
Monopoly
Concentration
Many firms
A few firms
Two firms
One firm
Entry and Exit
Barriers
No barriers
Product
Differentiation
Homogeneous
Product
Potential for product differentiation
Perfect
Information flow
Imperfect availability of information
Information
Significant barriers
High barriers
Porter’s Five Forces of Competition Framework
SUPPLIERS
Bargaining power of suppliers
INDUSTRY
COMPETITORS
POTENTIAL Threat of
ENTRANTS
new
entrants
Threat of
Rivalry among
existing firms
SUBSTITUTES
substitutes
Bargaining power of buyers
BUYERS
The Structural Determinants of Competition
BUYER POWER
• Buyers’ price sensitivity
• Relative bargaining
power
THREAT OF ENTRY
•Capital requirements
•Economies of scale
•Absolute cost advantage
•Product differentiation
•Access to distribution
channels
•Legal/ regulatory barriers
•Retaliation
INDUSTRY RIVALRY
•Concentration
•Diversity of
competitors
•Product differentiation
•Excess capacity &
exit barriers
•Cost conditions
BUYER POWER
• Buyers’ price sensitivity
• Relative bargaining
power
SUBSTITUTE
COMPETITION
• Buyers’ propensity
to substitute
• Relative prices &
performance of
substitutes
Threat of Substitutes
Extent of competitive pressure from producers of
substitutes depends upon:
• Buyers’ propensity to substitute
• The price-performance characteristics of
substitutes.
The Threat of Entry
Entrants’ threat to industry profitability depends
upon the height of barriers to entry. The principal
sources of barriers to entry are:
• Capital requirements
• Economies of scale
• Absolute cost advantage
• Product differentiation
• Access to channels of distribution
• Legal and regulatory barriers
• Retaliation
Bargaining Power of Buyers
Buyer’s price sensitivity
Relative bargaining power
• Cost of purchases as %
of buyer’s total costs.
• How differentiated is the
purchased item?
• How intense is
competition between
buyers?
• How important is the
item to quality of the
buyers’ own output?
• Size and concentration of
buyers relative to
sellers.
• Buyer’s information .
• Ability to backward
integrate.
Note: analysis of supplier
power is symmetric
Rivalry Between Established Competitors
The extent to which industry profitability is depressed by
aggressive price competition depends upon:
• Concentration (number and size distribution of firms)
• Diversity of competitors (differences in goals, cost
structure, etc.)
• Product differentiation
• Excess capacity and exit barriers
• Cost conditions
– Extent of scale economies
– Ratio of fixed to variable costs
Profitability and Market Growth
ROI (%)
30
25
20
15
10
5
0
Return
sales
Return
onon
sales
Return
investment
Return
onon
investment
Cash
flow/Investment
Cash
flow/
Investment
-5
0 to 5%
5% to
Less than -5% < -5%
-5% to 0-5% to 00 to 5%
5%
to10%
10%> 10% Over 10%
ANNUAL RATE OF GROWTH OF MARKET DEMAND
Supplier Power: The Impact of Unionization on Profitability
25
Profitability (%)
20
15
ROI (%)
10
ROS (%)
5
0
0%
1%-35%
36%-60%
61%-75%
Percentage of employees unionized
over 75%
Applying Five - Forces Analysis
Forecasting Industry Profitability
• Past profitability a poor indicator of future
profitability.
• If we can forecast changes in industry structure we
can predict likely impact on competition and
profitability.
Strategies to Improve Industry Profitability
• What structural variables are depressing profitability
• Which of these variables can be changed by
individual or collective strategies?
Drawing Industry Boundaries :
Identifying the Relevant Market
• What industry is BMW in:
– World Auto industry
– European Auto industry
– World luxury car industry?
• Key criterion: SUBSTITUTABILITY
– On the demand side : are buyers willing to substitute between
types of cars and across countries
– On the supply side : are manufacturers able to switch
production between types of cars and across countries
• We may need to analyze industry at different levels of
aggregation for different types of decision
Identifying Key Success Factors
Pre-requisites
forsuccess
success
Pre-requisites for
What do
customers want?
How does the firm
survive competition
Analysis of competition
Analysis of demand
• Who are our
customers?
• What do they want?
• What drives competition?
What are
drives
•• What
the competition?
main
• What are the
dimensions
of main
competition?
dimensions of competition?
•How
• Howintense
intenseis
iscompetition?
competition?
• Howcan
canwe
weobtain
obtainaasuperior
•How
superior competitive
competitive
position? position?
KEY SUCCESS FACTORS
Identifying Key Success Factors Through
Modeling Profitability: The Airline Industry
Profitability
Income
ASMs
=
Yield
x Load factor - Unit Cost
=
Revenue
RPMs
x
RPMs
ASMs
-
Expenses
ASMs
• Strength of
• Price competitiveness.
• Wage rates.
competition on routes.
• Efficiency of route
planning.
• Flexibility and
responsiveness.
• Customer loyalty.
• Meeting customer
requirements.
• Fuel efficiency of
planes.
• Responsiveness to chaanging market conditions
• % business travelers.
• Achieving differentia- tion
advantage
ASM = Available Seat Miles
• Employee
productivity.
• Load factors.
• Administrative
overhead.
RPM = Revenue Passenger Miles
Identifying Key Success Factors
by Analyzing Profit Drivers: Retailing
Sales mix of products
Return on Sales
Avoiding markdowns through
tight inventory control
Max. buying power to minimize
cost of goods purchased
ROCE
Max. sales/sq. foot through:
*location
*product mix
*customer service *quality control
Sales/Capital
Employed
Max. inventory turnover through
electronic data interchange, close
vendor relationships, fast delivery
Minimize capital deployment
through outsourcing & leasing
SUMMARY: What Have We Learned?
Forecasting Industry Profitability
•
•
Past profitability a poor indicator of future profitability.
If we can forecast changes in industry structure we can predict
likely impact on competition and profitability.
Strategies to Improve Industry Profitability
•
•
What structural variables are depressing profitability?
Which can be changed by individual or collective strategies?
Defining Industry Boundaries
•
•
Key criterion: substitution
The need to analyze market competition at different levels of
aggregation (depending on the issues being considered)
Key Success Factors
•
Starting point for the analysis of competitive advantage